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Monday, November 26, 2012

SPX Update: Looking a Step beyond Global Uncertainty

Humans hate uncertainty. We want guarantees, we want warranties, and we want insurance policies. We want to know the future, and we want promises (preferably in writing) which assure us of that future. And yet, what else is life but a constant, ever-shifting drama of uncertainty? The irony behind our desire for certainty and security is that the very tension of uncertainty is the same psychological force that so often drives our greatest gains in personal, and societal, growth.

Our extreme discomfort with uncertainty pushes us to invent, to learn, to grow, and to try and expand our understandings. It pushes us to become better people; to become more than we are today.

Global uncertainty can make the stock market seem like it should be an unpopular place -- and yet, always bumping against that global psychology and in opposition to it, there is personal uncertainty that makes the market appealing. Why do people invest in stocks? There simply is no other reason to invest, except the quest for financial security and expansion -- which is really just the quest to leave uncertainty behind.

Of course, we can no more eliminate uncertainty than we can become physically immortal; uncertainty is an intrinsic part of life (and of the universe itself, even down to the quantum level). Despite the obviousness of that fact, the majority of us spend our lives fearing (and often running from) the uncertainty of the unknown, in a perpetual state of low-grade anxiety. Thoreau described this perfectly when he said: "Most men lead lives of quiet desperation."

I believe understanding this psychology is a key to understanding the market. So often, people look at the seemingly ever-deteriorating world and say, "How can anyone buy stocks right now, with so much global uncertainty?" The problem is, this view only accounts for half the total psychology of uncertainty.

The traditional market wisdom says people buy and sell based on fear and
greed. That's true on a simplistic level -- but I believe that if one looks a bit deeper, one finds that
both fear and greed (in this case) stem from the exact same psychological source: the quest to overcome uncertainty and gain more security (even for people who don't seem to "need" more security -- we're rarely satisfied at a plateau, and more security for some can equate to additional wealth/power). So we're fearful when we're running from it, and we're greedy when we're chasing it -- but it all ultimately traces back to the same base desire.

This is why even when the world looks bleak and "everyone" is fearful, people are still buying stocks: at that moment, their desire to gain personal certainty/security is greater than their fear of global uncertainty.

This is one reason I think it's a mistake to look myopically at global uncertainty when deciding whether to buy or sell for the long-term. The fact is: there's always something going wrong with the world. And if that's all there was to consider in the psychology, then we'd do nothing but sell stocks short. Don't forget to consider the other side of that equation.

Speaking of uncertainty, the market is still in a position that leaves the intermediate-term unclear. Last update expected higher prices, though the S&P 500 (SPX) exceeded the upper edge of my target zone by a few points. Several of my intermediate indicators have now switched to buy signals, but others still remain on intermediate sells.

There are some indications that at least a minor top is due, but this rally has shown a lot more legs than virtually anyone expected, and that always leads me to believe that front-running is a bad idea for inexperienced traders. The approach I usually take at such times is to make a few quick stabs
at low-risk entry zones, but with very tight stops. If I get stopped
out, I have limited my risk -- but once I catch the turn (assuming I protect profits properly afterwards), it almost always
makes up for the small losses I've taken along the way.

Disclaimer: The above is not trading advice, and may or may not work for you. Consult your broker, your accountant, your lawyer, and your know-it-all in-law (the one who was driving you nuts over Thanksgiving) before doing anything at all, ever. Ask your doctor if you're healthy enough for trading. Side effects include high blood pressure, blurred vision, nail-biting, intermittent feelings of hopelessness and inadequacy, and the nagging sensation that you left the stove on.

It's worth noting that the rally has recovered 50% of the two-month-long decline from 1474 in only five sessions, so I'm giving a slight edge to the bulls here for intermediate-term odds. However, as mentioned, neither the bull nor bear intermediate case can be made with fervor yet -- so the chart below details both options, and notes the key invalidation levels. Sustained trade beneath 1365 would favor a retest or besting of the 1343 swing low, and a break of that swing low would almost certainly be huge trouble for bulls.

Below is a bit more detail on the bull case. The decline counts very well as two three-wave corrections lower.

The Philadelphia Bank Index (BKX) has also overlapped it first important upside level, but not its key intermediate upside level yet. Note that there is a lot of potential energy coiled in the present pattern. (continued, next page)

And finally, a chart which looks at several markets and some key support levels -- which these markets have recently rebounded from:

In conclusion, there continue to be early signals that indicate an intermediate low may be in place, but we're not quite to the zone where that can be considered confirmed. I think bulls have a slight edge here, but bears could still technically make a last-minute run at it and that has to be respected for the time being. While the short-term update caught the recent bottom quite well (see: November 19: Charts Point to at Least a Near-Term Rally), I'm maintaining my long-term neutral stance until the market tips its hand again -- likely sometime this week. Trade safe.

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